Why do airlines seem to be in a permanent state of crisis
This post somewhat follows and adds to one of my previous posts: “Air transport and environment, the challenge which will leave the industry dented”
It is an attempt of an answer to a series of questions asked by a colleague of mine:
” What are the changes that transport industries will have to face to use all the opportunities? Why are the transport industries the most touched by the crisis after banks? What did they miss? What are the similarities between Transport industries and banks? Can these common points alone explain the reason of bankruptcy? What needs to be done to reconciliate all the subsystems and make them work in harmony supporting each other rather than being an obstacle to each other? What are the level of innovation required to develop a sustainable transport system? What would be the new transport business? “
Cartoon embedded from the cartoonstock web site
In disguise of an answer to some of the questions I’ll note down my observations and opinions mainly focussing on the aviation sub-sector of the transport system then we can see if the reasons describe could be permeated to other sub-sectors:
The main struggle for aviation is that it is operating through an old model:
In rather simple terms, aviation, and more specifically civil aviation commercially transporting passengers and cargo, have historically been created by public funding [with many airlines seeing their birth as state owned enterprises]. There was little consideration to the size of the market in which they had entered. They were also based on a public service and were not operating necessarily for profit. This lead to un-optimised operating costs and a culture which assumed that that is the way it should be done. So the market ended up with too many of them operating at relatively high costs.
Then the crisis started coming alone challenging their business model:
1st crisis: Deregulation: With the progressive deregulation of the market and competition for hubs and airports, airlines found themselves too numerous. This pushed prices down and their profit margins [ticket prices had to fuel their untrimmed operating costs], thinner. Most started to trim their operating costs, some others which could not adapt and which were not helped by public funding [some unjustly were] died.
2nd crisis: Low cost airlines: Then low costs came along. They tapped on a revolutionised business model. Most were start ups and their operational costs and performance were trimmed from the very beginning. They did not have and legacy cultural inertia to change to a trimmed way of making business that the traditional airlines had. [in my opinion many of the low costs will be suffering the same issues as ‘traditional’ airlines very soon]
The result was even more airlines on the market, making the market very sensitive to tiny fluctuations in business. [E.g. the SARPs crisis in 2002-3] Profit margins continued to decline. Positive business cycles started not being enough to cover for the great losses during down turns.
Consolidation of the market started to happen at a slightly more accelerated pace. However mature consolidation is yet to happen. The need to travel is real. The market exist, but there is too much offer for the same thing and as a consequence the ticket prices are generally lower than whet they should be. [Whether the current market size in reality is sustainable is rather questionable] .
I believe that in the future further consolidation will continue to happen. Some through mergers others through pure bankruptcies. Governments, especially in Europe, will be less able to intervene because of their bad financial situation. Some [how many?] companies will go. The market will be shared by less, hopefully making it a bit more stable for those remaining. This will probably push ticket prices up.
I have not mentioned the third crisis yet: the cost of fuel. Cost of fuel amounts to around 40% of an airline’s operating costs. So the sensitivity on the profit margin of fuel prices which are highly volatile [$30 in 02, $60 in 05, $80 in 06, $60 in 07, $100+ in 08, $50 in 09, $80 in 10... or a 300% change in 8 years with multiple fluctuations in between]. This trend will continue as, even though engines are becoming more efficient, the fuel part of operating costs will remain significant and fluctuations in oil prices and the upward trend which will continue. The effect will be that the market will have to adapt. Ticket prices will have to go up, probably leading to a lower demand leading to further consolidation.
Crisis 4: Environment. Apart from prices going up, humanity, at least in western societies is becoming more aware of the environmental impact that certain activities have. People are questioning the sustainability of air travel especially where more environmental friendly options exist and could be developed further. To tap into this trend [and as part excuse to this trend] governments may be inclined to further tax aviation, thus accelerating consolidation.
As a conclusion the commercial airline industry has no option but to consolidate.
Airlines need to get into a strong position in order to survive [while others go, thus making the survivors even stronger] This can be done by:
diversifying their investments, thinking mobility, more than just air travel.
They can also look for niche markets within the industry as one of the problems is that there are too many offering the same.
They can also put pressure to reduce reliance on fossil fuels which inevitably are on upward trend. The industry is quite behind in this area with the first synthetic fuel based on natural gas tests being done by commercial airlines.
I do not necessarily see many similarities with banks. I am not an expert in the area, but I think consolidation is more mature in the banking industry. I think that banks have abused deregulation and under estimated the global effect of the risk they were taking to maximise profits in the shortest terms possible. And this is why they got [the rest of us] into crisis. I think that the airline industry is simply struggling in an environment because its generic business model and the size of the offer do no longer fit deregulation and the aviation’s dependence on what is now becoming a scarce resource.
Hope you find this useful to fuel the debate…
